Objectives

As we recall, Malthus did not have firms in mind when he formulated the Law of Diminishing Returns. But this law has applications Malthus did not envision, and we will see how to apply the law to a business firm. In the Reasonable Dialog of economics in the nineteenth century, the development of these ideas was a bit indirect. In about the eighteen-seventies, economists were rethinking the theory of consumer demand. They applied a version of "diminishing returns" and the Equimarginal Principle to determine how a consumer would divide up her spending among different consumer goods. (We'll get into that in another chapter). That worked pretty well, and so some other economists, especially the American economist John Bates Clark, tried using the same approach in the theory of the firm. These innovations were the beginning of Neoclassical Economics.

Following the Neoclassical approach, we will interpret "rational decisions to supply goods and services" to mean decisions that maximize -- something! What does a supplier maximize? The operations of the firm will, of course, depend on its objectives. One objective that all three kinds of firms share is profits, and it seems that profits are the primary objective in most cases. We will follow the neoclassical tradition by assuming that firms aim at maximizing their profits.

There are two reasons for this assumption. First, despite the growing importance of nonprofit organizations and the frequent calls for corporate social responsibility, profits still seem to be the most important single objective of producers in our market economy. Thus it is the right place to start. Second, a good deal of the controversy in the reasonable dialog of economics has centered on the implications of profit motivation. Is it true, as Adam Smith held, that the "invisible hand" leads profit-seeking businessmen to promote the general good? To assess that question, we need to understand the implications of profit maximization.